It's a company I have followed for quite some time, having initiated coverage when the share price was 54.5p ('Capital returns', 11 February 2011). I have remained positive ever since - and with good reason, too. That's because at the end of 2011 LMS's shareholders approved an asset disposal programme as a way of optimising value from its investment portfolio. In the past three-and-a-half years since then, LMS's board has returned £115m through three tax-efficient tender offers. This equates to approximately half the company's net asset value and three-quarters of its market capitalisation when shareholders approved the realisation process in November 2011. It's fair to say that the disposal programme has been a success, which is why I was happy to reiterate my buy advice at the time of the full-year results in March (‘Exploiting currency tailwinds, 17 March 2015).
Bearing this in mind, the company's latest net asset value of £136m includes net cash of £35.3m, quoted securities worth £13.2m, unquoted private-equity-style investments worth £53.2m, and investments held in funds of £43.8m. More than 60 per cent of the portfolio is in the US and LMS's 10 largest investments account for 84 per cent of the portfolio by value, so it's now concentrated in a small number of investments which should not be that difficult to divest.
Indeed, having reassessed the portfolio, I see no reason at all why the company and its investment managers can't successfully continue the asset disposal programme to its end and return a further 90p a share to shareholders. Furthermore, having banked £26.6m of asset sales in the first half, LMS's net cash now equates to 24p a share or a third of the share price, so there is ample surplus cash on the balance sheet to support another tax-efficient tender offer to shareholders pitched around net asset value of 94p, or almost a third above the current share price.
However, LMS's board are proposing a complete change in investment strategy and one that shareholders will have the opportunity to vote on at the forthcoming general meeting on Wednesday, 12 August. It's worth considering what is being proposed.
A sea change in strategy
Reflecting the plunge in oil and gas prices in the past year, which has led to massive disruptions in the energy sector, LMS is proposing to create a new investment team to capitalise on the investment opportunities in the bombed out energy sector.
The aim is to make between 10 and 20 investments with an average holding size of £20m to £40m by using at least £100m of the proceeds from the realisation of the remaining legacy assets, and by raising an additional £150m of new equity capital within 24 months. Property stalwart Robert Rayne, who has an interest in 34 per cent of LMS's share capital through a direct holding and family interests, and directors controlling 3.26 per cent of LMS's shares, intend to vote in favour of the new investment strategy.
Apart from Mr Rayne, the proposed investment team will include Tony Hayward, chairman of Glencore (GLEN: 205p) and former BP chief executive; Bernard Duroc-Danner, chief executive of LMS's largest quoted shareholding, New York Stock Exchange quoted Weatherford International (WFT: NYQ - $10.27), a global diversified upstream oilfield service group; and Tom Daniel, a person who has focused his expertise on energy sector investments in the past six years. Julian Metherell, a former Goldman Sachs banker and until recently finance director of Genel Energy (GEN: 377p), the largest independent oil producer in the Kurdistan region of Iraq, will act as an adviser to this investment team. In the past year under Mr Metherell's watch, Genel's share price has fallen by more than 60 per cent. Mr Hayward has just been appointed chairman of that company.
LMS director Nick Friedlos, chief financial officer Antony Sweet and Robert Rayne will continue to manage the realisation of the legacy portfolio if the new investment policy is implemented, but the roles of Mr Friedlos and Mr Sweet will change. Mr Friedlos will step down from the board and although Mr Sweet will remain as finance director on a base salary of £240,000 he will also oversee the transition of the administration of the company to an externally managed structure and look to reduce the costs associated with the legacy structure. Mr Friedlos will receive £1.3m and Antony Sweet will receive £650,000, the maximum amounts they are entitled to under the existing contract arrangements, and further payments of £700,000 and £350,000, respectively, linked to the amount of legacy assets realised over a two-year period.
Rewarding success equitably
Mr Friedlos and Mr Sweet are clearly being well rewarded, but I find the new carried interest arrangement for the new investment team a step too far. Not only will the new investment team become partners in Mr Daniel's new investment vehicle, St James's Asset Management, a company that will earn an annual management fee of 2 per cent of the energy assets under management, but subject to a 5 per cent preferred pre-tax return hurdle rate being passed each financial year on LMS's energy asset portfolio, then the partners will also be rewarded with 20 per cent of the increase in the adjusted net asset value of the energy assets too through a Jersey incorporated limited partnership in which the partners and the company will have equal shares.
I am more than happy rewarding success, but the hurdle rate is simply too low given that St James's Asset Management is already getting a 2 per cent annual management fee and the investment team will be partners in that company. Moreover, there is a proposal in the circular sent out to shareholders which reveals that St James's Asset Management will also receive a termination fee of £2.5m on its contract if the company doesn't raise the £150m of additional capital within the two-year timeframe. This is not just unusual, but is yet another liability shareholders are being asked to carry. Indeed, if the new investment team and adviser are that good, then surely they will have no problem attracting new funds from new investors? But if they struggle, then surely it's a reflection on their standing. Either way, there is no way shareholders should be asked to cover such a termination fee.
The other concern for existing shareholders is that with LMS's shares now priced 25 per cent below book value, valuing the company at £100m, then a capital raise of £150m-plus of new equity to pursue this new investment strategy would dilute net asset value per share unless the new equity is issued at the latest book value per share. New shareholders coming on board will clearly want to purchase at the lower market price, a situation at odds with the interests of loyal existing shareholders who have been holding the shares to reap the full value of the investment portfolio through capital returns.
LMS is seeking status as an investment trust for tax reasons, but there is no mention in the circular of a mechanism being put in place to narrow the share price discount to book value to protect the interests of existing shareholders given that a slug of new equity is planned to be issued.
Time to make a decision
Of course, the new investment policy proposed may work a treat and deliver rich rewards for all parties concerned. Mr Hayward and Mr Daniel have committed to buying £500,000 of new shares each in LMS within 12 months of the strategy being implemented. Then again, with the benefit of a 2 per cent management fee, and a 20 per cent carry on valuation gains on the energy assets above a very low hurdle rate, they can easily afford to.
In any case, I didn't recommended buying into LMS for exposure to the energy sector. If I wanted that then there are other ways of doing so than paying a new investment team handsomely for their expertise. And it goes without saying that if this new strategy is implemented then it changes the risk profile. Understandably, some shareholders have being selling out.
However, if enough shareholders reject the proposals at next month's general meeting then the company will have no choice but to continue with its ongoing realisation strategy as it has been mandated to do. Mr Rayne has a 34 per cent financial interest so it's still in his interest for the company to maximise returns on the legacy assets even if his new investment trust fails to get off the ground.
Needless to say, I would vote against the proposals at the forthcoming general meeting.
A long-distance call worth making
It hasn't taken long for the investment team at Marwyn Value Investors (MVI:238p), a closed-end investment company listed on the Specialist Fund Market of the London Stock Exchange, to reinvest the £61m net proceeds attributable to the company from the sale of a third of its stake in FTSE 250 film producer Entertainment One. Marwyn's interest in Entertainment One is held through its investment in an open-ended Master Fund domiciled in the Cayman Islands. I commented on the share sale a few weeks ago ('Acquisitions drive earnings upgrades', 7 July 2015).
Having initially invested £12m at 120p a share in Aim-traded Zegona Communications (ZEG:155p), a newly listed company established to acquire and operate businesses in the European telecoms, media and technology sector, Marwyn is backing Zegona's acquisition of Telecable de Asturias, the leading quad play telecommunications operator in Asturias, north-west Spain. Zegona is funding the €640m (£444m) consideration through a £251m placing at 150p a share, current cash resources and a new loan facility of €270m to settle Telecable's outstanding borrowings.
Founded in 1995, Telecable is a TV, fixed-line and mobile telephony, broadband and advanced business solutions provider with more than 162,000 residential and corporate customers. The vendors are global alternative asset manager The Carlyle Group (NSQ: CG) and Liberbank (MSE: LBK), one of Spain's largest banks. Telecable is being acquired on a debt-free, cash-free basis so the consideration equates to a reasonable 10 times cash profits of €63m in fiscal 2014 based on revenues of €131m.
A plan for value creation
Aim-traded Zegona was established by ex-Virgin Media executives Eamonn O'Hare and Robert Samuelson as a vehicle to acquire businesses in the European telecoms, media and technology sector with a view to delivering solid shareholder returns by implementing a 'Buy-Fix-Sell' strategy. Telecable's market-leading position and strong cash generation, coupled with attractive dynamics in the Spanish telecoms market and exposure to the country's economic recovery, were key factors in sealing this acquisition.
To create value for the company's shareholders, Mr O'Hare and Mr Samuelson intend to strengthen Telecable's product offering, particularly within television and mobile, providing a foundation for upselling and greater bundling of services to customers; increase revenues in Telecable's business-to-business division by serving larger corporations (in addition to the existing customer base) and by delivering more advanced data-orientated products; and realise productivity gains by optimising Telecable's mobile access agreement, enhancing procurement and investment focus.
It looks a sensible strategic buy to me and one that the directors of Marwyn are backing in a big way as the company is taking up £55m of the £251m placing at 150p each to give it a total holding of 46.6m shares worth £70m, representing 23.8 per cent of Zegona's enlarged share capital and 28 per cent of Marwyn's own share capital. The potential capital upside from Zegona's acquisition of Telecable aside, the board of Zegona has indicated that it intends to target a payout per share of 4.5p in fiscal 2016, equivalent to a 3 per cent dividend yield at the placing price, so this will provide Marwyn with a useful £2.1m income stream on its 46.6m shares.
Another deal in the offing
And Marwyn has announced today it has made a cornerstone investment in Gloo Networks, a technology company that has been established to acquire media companies, as part of a £30m initial fundraise alongside its Aim listing. The company intends to acquire and operate businesses with an enterprise value in the range of £250m to £1bn and will be led by digital strategy experts Rebecca Miskin (chief executive) and Juan Lopez-Valcarcel (operations director) who held high-profile positions at Hearst Magazines, the publisher of titles such as Cosmopolitan, and Pearson International, respectively. Liberum is the broker to the company and the founders of Marwyn, James Corsellis and Mark Brangstrup Watts, will also sit on the board.
In line with the funding strategy adopted by Zegona, expect a further fundraise when Gloo Network's first acquisition is announced. Targets being considered must be trusted consumer brands that appeal to attractive socio-economic groups and where there is scope to use data and technology to change their business models to ultimately unlock value and increase their profitability. Expect details of the target to emerge within the next three months, but clearly Marwyn is confident enough to back the company from an early stage, a strategy that worked a treat with Zegona and BCA Marketplace (BCA:170p), Europe's largest car auction operator.
Please note that I recommended buying shares in Marwyn at 220p ('Exploiting a value play', 5 May 2015) on the basis that it would be a low-risk way of playing the potential share price upside from FTSE 250 film producer Entertainment One, a view I still hold. So trading on a bid-offer spread of 236p-238p and offering 17 per cent share price upside to the top end of my target price range of 275p-280p, I continue to rate Marwyn's shares a decent value buy on a 20 per cent discount to book value.
MORE FROM SIMON THOMPSON...
At the end of April, I published an article with all of the share recommendations I have made this year. Since then I have published articles on the following companies in the past 12 weeks:
■ Marwyn Value Investors: Buy at 220p, target price 260p ('Exploiting a value play', 5 May 2015)
■ Pure Wafer: Buy at 113p, target 140p to 150p; Paragon: Run profits at 440p, but buy on a confirmed breakout above the 445p and new target of 500p; 600 Group: Buy at 16.5p, target 24p; Fairpoint: Buy at 127p, target 190p; AB Dynamics: Buy at 207p, target 230p ('Repeat buy signals', 11 May 2015)
■ Globo: Buy at 56p, target 69.5p; Greenko: Hold at 70p; Pittards: Buy at 128p ('Breakout looms for mobile wonder', 12 May 2015)
■ Macau Property Opportunities: Buy at 214p; Dragon-Ukrainian Properties & Development: Hold at 28p; Raven Russia: Hold at 53p ('Overseas property plays', 13 May 2015)
■ Trakm8: Run profits at 135p; Redde: Buy at 120.75p, target 140p; STM: Run profits at 45p, but conditional buy on close of 48p and new target of 60p ('Smashing target prices', 14 May 2015)
■ Bilby: Buy at 75p, target 100p ('Buy to build' growth play, 18 May 2015)
■ Bioquell: Buy at 148p, target 170p to 185p; Somero Enterprises: Buy at 140p, target 185p; KBC Advanced Technologies: Buy at 109.5p, target 165p; Inspired Capital: Hold at 14.25p ('Three value plays', 19 May 2015)
■ Renew Holdings: Buy at 315p, target range 350p to 375p; Manx Telecom: Buy at 198p, target 210p ('Renewing old acquaintances', 20 May 2015)
■ Marwyn Value Investors: Buy at 228p, target 260p; Charlemagne Capital: Hold at 13.5p; Bloomsbury Publishing: Hold at 178p ('Lights, camera, action', 21 May 2015)
■ Anite: Buy at 91.5p, target 110p ('Testing a breakout', 26 May 2015)
■ Character Group: Buy at 415p, target 525p ('Playtime', 1 Jun 2015)
■ Tristel: Run profits at 96p; Pure Wafer: Buy at 123p, target range 140p to 150p; Crystal Amber: Buy at 153p ('Hitting target prices', 2 Jun 2015)
■ B.P. Marsh & Partners: Buy at 150p, target range 170p to 180p; Moss Bros: Buy at 110p, target range 120p to 130p; SeaEnergy: Sell at 15p ('Exploiting a valuation anomaly', 3 Jun 2015)
■ Globo: Buy at 59p, target 69.5p; London & Associated Properties: Buy at 38.5p; Greenko: Hold at 44p ('Catalysts for share price moves', 4 Jun 2015)
■ Burford Capital: Buy at 148p, target 190p ('Legal eagles', 8 Jun 2015)
■ Market strategy ('Financial Market Watch', 9 Jun 2015)
■ Software Radio Technology: Buy at 29.5p, target 40p to 43p; Tristel: Run profits at 92p; Creston: Buy at 136p, target 150p; Sanderson: Buy at 69p, target range 80p to 85p ('Blue sky potential', 10 June 2015)
■ 1pm: Buy at 67p, target 80p; Vislink: Buy at 58p, target 70p ('Small-cap growth stocks', 11 Jun 2015)
■ Elegant Hotels: Buy at 105p, target 135p to 140p ('Checking into an elegant investment', 15 Jun 2015)
■ First Property: Run profits at 45p; AB Dynamics: Run profits at 225p and target 250p; Inspired Capital: Sit tight at 20p (Bargain shares updates', 16 Jun 2015)
■ Trakm8: Run profits at 159p, new target 180p; Anite: Sit tight at 126.75p; Trifast: Run profits at 129p, target 140p; Record: Buy at 37p ('Small-cap wonders', 17 Jun 2015)
■ Inland: Run profits at 71p, target 80p; KBC Advanced Technologies: Buy at 110p, target 165p; Caretech: Buy at 237p, target 300p ('Riding an earnings upgrade cycle', 18 Jun 2015)
■ Ensor: Buy at 97p, minimum target 125p ('Building up for a takeover', 22 Jun 2015)
■ GLI Finance: Buy at 54p, target 80p; Pittards: Buy at 128p; Netplay TV: Buy at 9.5p ('A triple play of small-cap picks', 23 Jun 2015)
■ Bilby: Run profits at 97p; Safestyle: Run profits at 220p; Epwin: Run profits at 134p ('Soaring small-caps', 24 Jun 2015)
■ Faroe Petroleum: Buy at 86p, target 100p; Greenko: Hold at 65p; Communisis: Buy at 48p ('A slick investment', 25 Jun 2015)
■ Mountview Estates: Buy at 12,250p; Inland: Run profits at 71p, conservative price target ('Running bumper profits', 29 Jun 2015)
■ Redde: Run profits at 138p, target range 150p to 155p; Trakm8: Buy at 175p, target 200p; Cohort: Buy at 312p, target 365p; Burford Capital: Buy at 175p, target 190p; Flowtech Fluidpower: Buy at 135p, target 155p ('Riding earnings upgrade cycles', 7 Jul 2015)
■ Crystal Amber: Buy at 161p; Stanley Gibbons: Buy at 258p; Somero Enterprises: Buy at 150p, target 185p; Globo: Buy at 49p, target 69.5p ('A quartet of small-cap buys', 8 Jul 2015)
■ H&T: Buy at 200p; STM: Buy at 47p, target 60p; Stadium: Buy at 113p, target 140p ('Exploiting upgrades', 9 Jul 2015)
■ Cambria Automobiles: Buy at 57.5p, target 75p ('Driving a re-rating', 13 Jul 2015)
■ Walker Crips: Buy at 47p, target 60p; 600 Group: Buy at 18p, target 24p; Henry Boot: Buy at 235p, target 260p ('A trio of small-cap value plays', 14 Jul 2015)
■ Bilby: Buy at 90p, target 120p; 32Red: Buy at 67.5p, ('Exploiting a valuation anomaly', 20 July 2015) target 90p; Marwyn Value Investors: Buy at 244p, target 275p (‘Acquisitions drive earnings upgrades’, 15 July 2015)
■ Vislink: Buy at 53p, target 70p ('Awarding success', 16 July 2015)
■ SPARK Ventures: Buy at 4.5p (‘Exploiting a valuation anomaly’, 20 July 2015)
■ W.H. Ireland: Run profits at 120p, target 140p; Safestyle: Run profits at 235p; Charlemagne Capital: Sell at 11p (‘Cash rich small-caps’, 21 July 2015)
■ Amino Technologies: Buy at 150p, target 180p; Arbuthnot Banking: Buy at 1,530p; Globo|: Buy at 49p, target 69.5p ('Primed for major re-ratings', 22 July 2015)
■ SPARK Ventures: Buy at 4.5p; Entu: Buy at 115p, target 165p ('Cashed-up for gains', 23 July 2015)
■ Capital & Regional: Buy at 60.25p, target 70p ('Hot property', 27 July 2015)
■ Simon Thompson's book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 and is being sold through no other source. It is priced at £14.99, plus £2.95 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stockpicking'
